Professional Documents
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DOI: 10.5923/j.ijfa.20140306.01
Abstract Both IAS 7 and SFAS 95 allow the option of reporting either the direct or indirect method when preparing
statement of cash flows. Both the IASB and the FASB consider the direct method as the preferred method of presenting cash
flows from operations. Different studies in the literature find that the majority of the companies are using only the indirect
method. The purpose of this study is to support one argument of the following: when preparing statement of cash flows, the
preparers should use the direct method, the indirect one, or both. This study summarizes the advantages of direct and indirect
methods, studies the possibility of using the information available to convert a statement of cash flows using indirect method
to direct method, studies the possibilities of using the information available in the financial statement to prepare statement of
cash flows using direct method, studies the effect of cost using either method compared with the other one. The results show
that we can estimate either the direct method or the indirect method of statement of cash flows but the estimated statement
does not give 100% accurate results. If the users of financial statements accept less than 100% accuracy in the statements,
then companies can prepare either an indirect or a direct method of statement of cash flows. Otherwise, the company should
ask prepares to prepare both methods or use a cost-benefit analysis to determine which method that should be used. My
argument ends with maximizing the benefits is achieved by providing statement of cash flows using both direct and indirect
methods.
1. Introduction
Debating the form of disclosure of operating cash flows
has been central in the development of all cash flows
reporting standards over the past three decades. At the heart
of this debate has been whether to mandate or allow firms the
choice of reporting operating cash flows using the indirect or
direct method (Clacher et al., 2013). The International and
US reporting requirements are similar. The IAS 7 states that
"An entity shall report cash flows from operating activities
using either: (a) the direct method ; or (b) the indirect
method entities are encouraged to report cash flows from
operating activities using the direct method." (IAS 7, par.
18-19). Similarly, SFAS 95 encourages enterprises to report
cash flows from operating activities directly by showing
major classes of operating cash receipts and payments (the
direct method). Enterprises that choose not to show
operating cash receipts and payments are required to report
the same amount of net cash flows from operating activities
indirectly by adjusting net income to reconcile it to net cash
flows from operating activities (the indirect or reconciliation
* Corresponding author:
b.abuabbas@psut.edu.jo (Bassam M. Abu-Abbas)
Published online at http://journal.sapub.org/ijfa
Copyright 2014 Scientific & Academic Publishing. All Rights Reserved
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Bassam M. Abu-Abbas: Direct, Indirect, or Both Methods of Reporting Operating Statement of Cash Flows
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Bassam M. Abu-Abbas: Direct, Indirect, or Both Methods of Reporting Operating Statement of Cash Flows
8. Conclusions
Both the IASB and the FASB consider the direct method
as the preferred method of presenting cash flows from
operations. The IAS 7 states that "An entity shall report cash
flows from operating activities using either: (a) the direct
method ; or (b) the indirect method entities are
encouraged to report cash flows from operating activities
using the direct method." (IAS 7, par. 18-19). Similarly,
SFAS 95 encourages enterprises to report cash flows from
operating activities directly by showing major classes of
operating cash receipts and payments (the direct method).
Previous literature find that the direct method is more
consistent with the objective of a statement of cash flows,
improve the prediction ability of future operating cash flows,
and provides more useful information to both creditors and
investors. On the other hand, the indirect method is easier for
preparers to create, simple for users to analyze, highlights the
differences between net income and net cash from operating
activities, and less cost to implement.
The purpose of this study is to support one argument of the
following: when preparing statement of cash flows, the
preparers should use the direct method, the indirect one, or
both. The FASB (1987, para. 110) concluded that neither
method provides benefits sufficient to justify requiring one
and prohibiting the other and that both the direct and the
indirect methods provide potentially important information
(FASB 1987, para. 119). However, the Board believes that
the direct method provides more useful information and
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Bassam M. Abu-Abbas: Direct, Indirect, or Both Methods of Reporting Operating Statement of Cash Flows